Title

Layoffs as Part of an Optimal Incentive Mix: Theory and Evidence

Author(s)

Anders Frederiksen Anders Frederiksen (Stanford University)

Elod Takats Elod Takats (Princeton University)

Abstract

Firms offer highly complex contracts to their employees. These contracts contain a mix of various incentives, such as fixed wages, bonuses, promise of promotion, and threat of firing. This paper aims at explaining the reason why this incentive-mix arises. In particular, the model focuses on why firms are combining promotions and bonuses with firing. The theoretical model proposed is a job-assignment model with heterogeneous employees. In this model the firm is concerned about job assignment, because the overall productivity of the firm depends upon the quality of the employees and their allocation to jobs. The model shows that firing has a dual role. Firing creates incentives for the employees, and it is used as a sorting device that allows the firm to improve workforce quality. Thus, quality-concerned firms might want to combine cost-efficient incentives such as promotions and bonuses with firng. To comply with the Gibbons and Waldman critique, a large set of the model's broader predictions is stated explicitly and tested on the personnel records from a large pharmaceutical company. The model's predictions are shown to be consistent with the data.

Creation Date

2005-08

Section URL ID

IRS

Paper Number

502

URL

https://dataspace.princeton.edu/bitstream/88435/dsp015712m6547/1/502a.pdf

File Function

Jel

J63, J30, J41, M50

Keyword(s)

Suppress

false

Series

1